EURUSD slips on uncertainty about the German-French proposal of a common EU COVID-19 fiscal stimulus, dovish ECB minutes and growing cold war tensions between U.S.-China

EURUSD closed around 1.0930 in the U.S. session Thursday, edged down almost -0.26% on uncertainty about the German-Franco proposal of a common EU corona fiscal stimulus (recovery fund), and growing cold war tensions between U.S.-China over COVID-19 issues. EURUSD further slips from the EU fiscal bazooka optimism high of 1.1017 to a low of 1.0888 in the mid-EU session Friday, down over -0.50% on a dovish ECB minute (Apr meet) as ECB does not see a meaningful economic recovery in the coming days and may also expand its pandemic QE in June.

As a pointer, EURUSD jumped almost +1.60% in a 4-day winning streak (from last Friday, 15th May) on hopes & hypes of a joint EURO bond/fiscal stimulus to battle Eurozone corona recession. Overall, EURUSD slumped -0.51% in May (till day) as it was undercut by German court’ adverse verdict on ECB QE (APP), renewed Trump trade war tantrum, while also buoyed by the prospect of a joint EU fiscal/corona stimulus approach, visible flattening of the COVID-19 curve and the gradual ease of corona lockdown across the EU/Europe.

On Monday (18th May), EURUSD soared almost +0.90% after a report that German Chancellor Merkel and French President Macron has arrived a funding deal (like a common Eurobond) for the Eurozone, which pledged €500B to help various EU states to rebuild their economy devastated after the corona carnage. The Eurozone countries (EU states), which will accept the funds, may not be required to pay it back at all; i.e. it will be eventually turned into EU grants and the ultimate liability may be added to the EU budget for around €1T (2020-27).

Statement by Merkel on 18th May: Overcoming the crisis united and emerging from it stronger

Ladies and gentlemen, not only am I happy to have had a video conference with French President Emmanuel Macron today, as has become standard in the meantime during the pandemic, I’m also pleased that we’re able to hold the press conference today in a way that will allow you to ask the two of us questions, both in Berlin and Paris. So my warm regards to you in Paris.

We spoke today about how France and Germany can play a part in overcoming the pandemic crisis, which we agree is the severest crisis the European Union, has ever faced. A crisis of this type requires the right kind of answers.

Franco-German cooperation and friendship call on us to send this message, in the awareness that there are 27 of us.But I believe that if Germany and France get the ball rolling, this will help us to reach consensus in Europe and support the process of reaching consensus. We need to take action. We need to take action at the European level so that we emerge sound and stronger from this crisis.

The Finance Ministers have already launched a large package of guarantees as regards the European Investment Bank, the ESM, and SURE unemployment insurance for reduced hours compensation benefits. This has been approved by the Heads of State and Government. That was a tremendous contribution, a first step. We now want to implement this quickly.

But it is not enough. We already said at the time that we need a recovery fund. Germany and France have spoken in depth about what form this recovery fund could take.

What is the goal?The goal is that Europe will emerge united and mutually supportive of this crisis. We know that the virus affects our countries in different ways and that this is why we face a risk that the economic impact of this virus will undermine EU cohesion and that the cohesion we actually need no longer exists. That is why the recovery fund must play a part in enabling all countries in Europe to respond in the right way. This requires an extraordinary, one-off exertion, one that Germany and France are willing to make.

Europe needs to stand together. We need rapid economic recovery. That is why we want to launch a temporary fund of 500 billion euro for EU budget expenditure.In other words, this would not provide loans, but rather budget funding for the sectors and regions hit hardest by the crisis. We firmly believe that it is both justified and necessary to now provide funding for this from the European side that we will gradually deploy across several European budgets in the future.

Naturally, all this needs to comply with the European treaties and European budget law and of course it also affects parts of the member states’ budget planning. It is thus crucial that a recovery fund of this type be based on a sound legal footing and reflect national parliaments’ budget autonomy.

However, we will set up the fund in this way. That means that the Commission will raise money so that the recovery fund and the medium-term budgetary framework will then make up the overall EU budget and provide significantly more funding in the first years after the crisis – namely these 500 billion euro – in order to support the affected countries and sectors via the budget.

This exertion is necessary. We firmly believe that. This will lead to greater cohesion in Europe than is currently the case.

Furthermore, we will work very closely together on making the European Union fit for the future. Naturally, this funding will also be used to invest in digital transformation, the Green Deal, and tackling the climate catastrophe, thus generating new momentum for the future. In the future – and this is also part of the Franco-German initiative – we will work very closely together on health and the lessons we learn from this crisis.

All in all, I’m very glad that Germany and France can announce this initiative today. It is what I believe we need so that we can play our part in the future of the European Union.

Furthermore, after this pandemic, we will run the member states’ Conference on the Future of Europe with the European Parliament and the Commission in a different way than we had originally planned, as we need to talk seriously about where there were shortcomings in Europe and what will define the future of the European Union. This can also include amendments to the treaties; it can include far greater integration. We are presenting the short answer to the crisis today, so to speak. The long answers will need to be discussed because Europe must be developed further.

But this Eurobond proposal by Germany and France is subjected to a formal EU approval and various wealthy EU states like Austria, Denmark, Netherland, and Sweden (so-called ‘Frugal Four’) already rejected the plan, calling it too generous. The EU Frugal Four group is also working on a counter-proposal on providing loans (monetary stimulus) rather than grants & subsidies (fiscal stimulus) to those fragile EU southern states (like Italy, Spain, and Greece), requiring an urgent fund to prevent the current spate of short term corona recession into a long term economic depression. The Frugal Four’ counter-proposal may be ready shortly.

On Monday (18th May), just hours after the announcement of the German-Franco initiative of €500 common EU fiscal stimulus plan, the Austrian Chancellor Kurz tweeted that he had objections to the plan. And on the next day (19th May) he announced he would work on his own ideas for the recovery fund with the Frugal Four group. Kurz and his Finance Minister said:

We believe that it is possible to boost the European economy and still avoid a mutualization of debts. The Frugal Four’s main problem with the Franco-German proposal is the decision to award grants instead of loans. I have already pointed this out in my tweet after the Merkel-Macron presentation. We are ready to help those countries that suffer most from the effects of the pandemic. However, money is only available in the form of loans, not grants (as Merkel and Macron had suggested). We still reject the financing of non-repayable subsidies because now is the time to invest in the future, instead of covering the costs of past debts.

Conclusions:

Overall, Merkel may face a tough challenge from other EU states (northern and eastern) for her EU recovery fund (grants) for southern states as many wealthy states want to provide loans rather than outright grants. But those fragile EU states (mostly Southern-Italy, Spain and Greece) are fiscally very weak (as per EU standard) and thus maybe not in a position to afford more debts, even if offered virtually free by the ECB (through various instruments); they have to at least pay back the principal for any debt.

For Germany (Merkel), the integration of the EU is vital amid horrible corona carnage for southern states, having relatively poor resources and less fiscal space (Italy, Spain, and Greece). Spain and Italy are not very happy about the EU austerity and tough fiscal rules. If those fragile southern EU states go for special COVID-19 bond issuances, they have to pay a relatively higher coupon rate (interest), and thus they need EU/ECB/German cover (guarantee) for their debt.

Merkel actually took the initiative of corona recovery fund to bail out those fragile southern EU states after the 5th May ‘bombshell’ verdict of the German Constitutional Court, preventing Germany’s Central Bank (BUBA) to participate in the ECB QE (APP) as some portion of the APP may be illegal for EU treaty and other rules. So, now the whole ECB APP may be under serious question. Thus, Merkel, who usually had some reservations about the joint Eurobond concept previously, suddenly turned almost 360° and proposed a joint EU corona bond.

In any way, even if such a joint EU corona bond of €500B is ultimately approved for bailing out fragile southern EU states, it may be conditional upon the implementation of various structural reforms, which is politically very tough for those states. And even after the approval of this €500B fiscal stimulus, it may be too little and too late for the fragile southern EU states (Italy, Span, and Greece to example) and we may again see waves of Italexit, Grexit and even Catalexit, as all these Euro exits narrative may be the result of excessive EU austerity and the concept of a common currency (EUR) with no ‘printing’ authority. There is no common fiscal authority, but common monetary authority in the EU.

As per some Eurosceptic Italian politicians, EUR is basically the German Deutsche Mark and Germany has floated the concept of EUR/EU to devalue its currency (in the disguise of a common currency-EUR) for the competitiveness of its export. As a reminder, Germany is an export-heavy economy.

Looking ahead, talking about export, both China and the U.K. are big trading partners of EU/Germany. Thus renewed U.S.-China trade/cold war rhetorics and Brexit uncertainty (trade deal or extension of U.K. transit period or no trade deal hard Brexit) is also bad for the export-heavy German/EU economy.

And ‘Tariff Man’ Trump may also target EU/Germany/France apart from China to impose additional tariffs as ultimately Trump wants a nationalist image and also higher revenue to win the next election and also to lower the surging U.S. fiscal deficit. Thus, ahead of Nov’20 election, Trump may ramp up his Chinese as-well-as EU narrative (old trade war playbook OF 2018-19) as Trump always says the EU is a small version of China but maybe worse than China as Europe is also ripping off America in trade as-well-as in military (NATO) bill.

Bottom line:

As EUR is now basically a funding currency, not a growth currency, and combined with that, an uneven fiscal stimulus across various EU states (lack of common fiscal authority), the EURUSD may hover within 1.10-1.05 rather than 1.10-1.15 in the coming days. But lower EURUSD may be also ideal for EU policymakers to revive growth as it’s helping the EU export. As a pointer, overall the EU is an export savvy economy.

Technical View: EURUSD

Technically, whatever may be the narrative, EURUSD has to sustain above 1.10500 for a further rally to 1.11100/1.11500*-1.12200/1.12700* and 1.13100*/1.13500-1.14300/1.15000* in the near term (under bullish case scenario).

On the flip side, sustaining below 1.10400-1.10250*, EURUSD may fall to 1.09800*/1.09000-1.08700*/1.08300 and further to 1.07500/1.07200*-1.06600/1.06300* and further 1.06000/1.05500-1.04900*/1.03200 in the near term (under bear case scenario).

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